Office Depot Falling Behind

The office supply company is performing poorly and lacks the scale to compete with larger rivals.

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Tim Begany

NEW YORK ( StreetAuthority) -- Finally, the stock market and economy are doing noticeably better.

Perhaps the most welcome sign is unemployment, which has gradually worked its way down to 8.5% from a recession high of 10.1% in October 2009. The S&P 500 has risen nearly 9% in the past three months and investors have been forecasting progressively less market volatility, as shown by a 35% decline in the Chicago Board Options Exchange (CBOE) Volatility Index during the past three months.

Not all the stocks that have been participating in the recent rally deserve to, however, because the companies they represent simply don't have a very bright future.

Even though these stocks have been going up with the overall market, plenty of them could drag a portfolio down in the long-run. I wouldn't recommend these stocks to anybody because they're likely to seriously underperform and lose you money, even if there's an extended bull market.

Office Depot has already been a poor performer for many years, losing shareholders 18% annually for the past decade. Plummeting share prices haven't created a great value play, as some might be tempted to believe, though, as it might for any number of solid companies like General Electric ( GE), 3M ( MMM) or Caterpillar ( CAT), to name a few.

I think Office Depot is a stock to avoid at any price because the company no longer sits on a solid foundation. Sales, which have grown at an anemic 1% rate for the past five years, will contract by 1.5% annually for the next five years, analysts estimate.

This is because about 80% of its sales, currently $11.5 billion annually, are from small businesses, which were particularly hard-hit by the recession. Many are still in survival mode and could take a lot longer than larger companies to fully recover and resume normal spending. Exactly how much longer is almost impossible to accurately predict, but I wouldn't be surprised to see the small business recovery drag out another four or five years, perhaps even longer.

Besides relying far too heavily on hurting small businesses for revenue, Office Depot lacks the scale, bargaining power and cost advantages of much larger competitors. Staples ( SPLS), for example, generates more than twice as much as Office Depot in annual sales -- $25 billion in 2011. Staples' operating margin of 6.4% in 2011 was markedly better than the 4.6% industry average and far superior to Office Depot's nearly 1% operating loss.